Broker-dealers have seen the writing on the wall — adapt to the changing industry or risk extinction, according to a new report from Cerulli Associates.
Amid vanishing commission-based revenue due to the fiduciary rule and competitive threats from RIAs, broker-dealers can only survive by embracing advisory services and new technology, says the study, released last week by the Boston-based consulting and research firm.
Financial Planning reviewed a summary of the report: “Saving the Dinosaurs: Industry Trends Threaten U.S. Broker-Dealer Structure.” The changes to the industry make the original business model of big IBDs such as LPL Financial and Cetera Financial Group, and wirehouse firms like Morgan Stanley “potentially irrelevant,” the study says.
“The growth of advisory programs, independent RIAs, and regulation all call into question the future of the BD structure,” according to Cerulli. BDs “must carefully examine their value proposition for advisors,” the study says.
TRACKING THE FLOW
HighTower Advisors, United Capital and Dynasty Financial Group and hybrid-serving BDs like Purshe Kaplan Sterling Investments are carving out more assets from wirehouses and traditional IBDs each year.
The share of advisor-managed funds at independent and hybrid RIAs grew to 23% of the market in 2016 from 15% in 2006, Cerulli says. Fewer than one-quarter of advisors predict they will charge commission fees next year, down from 32% last year, according to data the firm collected in partnership with IMCA and FPA.
Higher payouts, greater autonomy and a more personable culture at RIAs appeal to wirehouse advisors, the report says, citing surveys. Additionally, consumers better grasp the conflicts of interest “inherent” in parts of the wealth management space following the financial crisis, Cerulli says.
The fiduciary status of RIAs does leave them in a stronger position than IBDs with prospective clients, according to recruiter Louis Diamond of Diamond Consultants. He views the fiduciary rule as the primary concern facing IBDs due to its direct impact on longtime revenue sources like 12b-1 fees.
BDs such as PKS, Mutual Securities and Private Client Services serve as scaled-down “friendly broker-dealers” for dual-registered advisors, Diamond says. The approach, which is becoming more popular, helps advisors avoid the administrative fees and pay grids of larger BDs such as LPL, he says.
“The economics are more compelling. But I think the biggest reason is that they’re built to serve hybrid advisors,” Diamond says. “If someone has to keep a broker-dealer, it’s by far the lesser of all evils.”
WHO’S AHEAD OF THE CURVE?
IBDs have already begun to respond to the shifts in the market by consolidating into giants such as LPL and boutique firms of 500 to 2,000 advisors like Commonwealth Financial Network. LPL Financial’s Aug. 15 acquisition of National Planning Holdings could push its headcount past all of the wirehouses.
Most wirehouses have pulled back from recruiting deals that once ran as high as 300% of an advisor’s gross revenue, Cerulli notes. The firms emphasize their increasing advisory and managed assets, with Morgan Stanley reporting $19.9 billion in fee-based asset flows in its most recent earnings.
“If BDs recruit less aggressively, they become more dependent on advisors attracting new clients as a source of growth,” according to the Cerulli study. It also noted that the recruiting pullback is helping the wirehouses’ competitors peel off advisors from their ranks.
“BDs must solely compete on their own merits if they want to attract advisors. Advisors, without the allure of guaranteed money, can more seriously consider other affiliation options, such as smaller firms or the independent model.”
The threats are also causing big players to innovate to better serve advisors, Cerulli says. The report praises Morgan Stanley’s algorithmic assistant, LPL’s virtual assistant and Cetera’s facial analysis tool, as well as citing the advisory technology increasingly offered by asset managers such as BlackRock.
BDs of all sizes need to make changes because what advisors expect from them is shifting, Diamond says. The challenges to their business model will not force them into extinction, but they will continue to roil the space, he says.
“The number of IBDs is definitely going to go down. It’s becoming harder to operate these things and more costly,” Diamond says. However, he adds, IBDs fill an important role for RIAs. “It’s often times like an incubator. So, I think there will always be a place for them.”